What are some of the key risks of investing in the financial services sector?

The globalization of the financial sector combined with the increased reliance on Internet-related services has created new sources of risk in financial services. Regulatory risk always exists, because new financial regulations in other countries can have a direct impact on the local economy. The financial services sector is also vulnerable to credit risks, because a sudden freeze or loss of credit can disrupt daily operations to the point of collapse. This was evident in the collapse of both Bear Stearns and Lehman Brothers in 2008.

Liquidity risk is another danger for the financial services sector. This occurs when an asset or investment loses value, and cannot be sold in time to prevent a loss. Credit services and investment banks rely heavily on the value of investments such as property and houses that can be used as collateral. If those investments suddenly lose value, the financial institution may lose its ability to recoup its initial loan or investment. This was a major problem during the mortgage crisis of 2007.

Operational risk is another danger that brokerage firms face. This occurs when internal mismanagement, poor planning or negligence within the financial services industry leads to losses for the firms and the people that invest in them. Operational risk comes down to human error, which is a constant danger, because financial services rely heavily on human speculation regarding how the markets will react in the future.

Security risks are another constant concern, especially in the age of the Internet. The theft of financial information or the compromising of a financial institute's internal systems by a hacker can have devastating consequences. Data theft also hurts the confidence of the consumer, and can cause investors to move their money elsewhere. Identity theft is a constant concern for both consumers and investors, and the financial services industry needs to maintain an image of security.

Another risk for investors in the financial services industry concerns business continuity. This means that a firm is able to continue operations after an unexpected service disruption. Natural disasters, terrorist attacks and equipment failure are all examples of unforeseeable events that can severely cripple asset management and other financial services. Financial institutions need to have a pre-existing plan in place for nearly any eventuality, so that they are prepared to continue serving their clientele during and in the aftermath of an emergency.

It is important to be aware of all of these risks when investing in the financial services sector. Proper research and knowledge helps an investor recognize these risks so that they can be properly mitigated. This is another reason why diversity is so important when it comes to investment. The more diverse an investment profile, the more the risks in that profile are compartmentalized and risk exposure is limited. This is why it is so important to never put all of the "investment eggs" in a single basket.